Stock Market Smarts: The New Normal
GIC rates at 6 per cent? We may not see them again this decade or perhaps even longer
Anyone who still hankers for the good old days when GICs paid 6 per cent or more is going to have to wait a long, long time. It’s too much of a stretch to say those days are gone forever, but it’s very possible that we could go through the rest of this decade without seeing a return to those levels.
That’s the message we’re getting from the bond market. Professional bond traders are a pretty smart bunch – some of them pull down multi-million salaries – and their actions are telling us that interest rates are unlikely to make any serious upward move in the near to medium future.
I’ve written before about the surprising performance of the bond market this year and it just keeps continuing. Back in January, most forecasts, including mine, predicted a weak year for bonds. That was based on the assumption that the economic recovery would continue to gain momentum, pushing interest rates higher in the process.
That’s not happening, at least not yet.
Bond traders see all of these crosscurrents at work and their conclusion has been that fixed-income securities are underpriced, even at the current low levels. As a result, they have been buying bonds, driving prices higher. As of Aug. 1, the FTSE TMX Universe Bond Index was showing a year-to-date gain of 5.81%. And the trend line shows no sign of changing; the gain for July alone was almost 1%.
What is even more telling is the performance of long-term bonds (10+ years). If traders expected rates to rise, the price of long-term bonds would decline to reflect that. Instead, they’re rising. The year-to-date gain for the FTSE TMX Long-Term Bond Index is an astounding 11.39%. Real return bonds, which are also long-term in nature, have done even better at 14.08%. That’s even better than the S&P/TSX Composite Index, which was ahead 11.7% as of Aug. 1.
Not surprisingly in light of this, GIC rates have been drifting lower, not higher as was expected at the start of the year. Major banks like Royal and TD now offer only 2% on five-year non-redeemable GICs. That’s less than you could have received in the spring and it’s not even keeping up with the current rate of inflation. There is no reason to expect that to improve any time soon.
Annuities have been another casualty of the low rate era. The price of these contracts, which guarantee a fixed payment for a set number of years or for life, are highly interest rate sensitive. Right now, they offer close to rock bottom payouts for your money. If you want to buy one, you can postpone action until rates move higher but you’re likely to wait a long time.
Bank of Canada Governor Stephen Poloz said recently that interest rates in the next few years probably won’t need to be as high as they were in the past to keep inflation under control. Bank of England (and former Bank of Canada) Governor Mark Carney expressed a similar view, saying, “The old normal … is not likely to be the new normal” in forecasting an extended period of low rates. Federal Reserve Board Chair Janet Yellen has indicated that interest rates in that country will be muted for a long time after the quantitative easing program ends in the fall.
This leaves conservative investors facing a stark reality. The long-expected recovery in interest rates has been postponed indefinitely. This means GICs are going to continue to offer negligible or even negative real returns (after inflation), perhaps for several years. If you’re not willing to live with that, you must accept more risk. That is the new normal.